This summer, investors at ten large Wall Street brokerages will have a choice of research.
As part of the global settlement reached last year with New York Attorney General Eliot Spitzer, the ten firms must pay more than $400 million to buy so-called independent research, free of investment banking influence, and deliver it to their customers.
The settlement essentially guarantees these smaller independent research firms new business. The brokerages are expected to choose which independent firms by the end of July.
As a result, the landscape of independent research firms will be a very different one in five years, and some firms know the stakes are high
Argus Research CEO John Eade is taking a gamble: He's in the process of nearly doubling his research staff to 22 and increasing the number of companies covered by 67 percent to 500. He's also upgraded the company’s computer network.
Argus, and dozens of other firms, are ramping up — hoping to will win some of the $432 million allocated to independent research under the global settlement.
“I hope 5 years from now I have better brand recognition, better relationships with these firms and a stronger product,” said Eade. “I think it's a great opportunity for our firm and I think it's worth the risk.”
Under the Wall Street settlement, brokerages must contribute to the research fund. Merrill Lynch, Morgan Stanley, Salomon Smith Barney will each pay $75 million; Goldman Sachs and Credit Suisse First Boston will pay $50 million; Bear Stearns J.P. Morgan Lehman Brothers and UBS will pay $25 million and Piper Jaffrey will pay $7.5 million. The payments will be spread over the next five years.
The independents say it's not a lot of money split among the firms. But it's a way of funding expansion, winning new business and building a reputation and brand name.
“We've got a little bit of a bubble in the independent research space,” said Sandy Bragg at Standard & Poors which, along with Argus and even Morningstar, are some of the firms jockeying for research funds.
That’s in sharp contrast to the trend among the large brokerages. While Merrill Lynch has seen its analyst corps shrink by 18 percent from some 850 analysts in 2000 to just over 700 today. S&P, although much smaller, has nearly doubled its stable of analysts from about fifty to more than 90 today.
To compete against the larger players, many smaller independent firms have banded together in consortia. Still, many say the advantage will go to the bigger players, according to Scott Cleland, CEO of the Precursor Group and head of Investorside Research, a group representing independent research firms.
“You need a certain amount of scale and a certain amount of heft and credibility to play in the global settlement,” he said.
The hope behind funding the independents is that investors will get unbiased calls, like the one Cleland made two years ago when he predicted the bankruptcy of WorldCom.
“We were essentially alone against about a hundred analysts on the street,” said Cleland. “Saying that WorldCom was kind of like a dead model walking. Routinely, (former WorldCom CEO) Bernie Ebbers called me ‘the Washington idiot analyst.’”
But critics say not all independent research is good just because it is independent.
“A lot of what passes for independent research providers tend to be repetitive, tends to be purely quantitative or technical in nature, and rather not evaluative,” said Frank Fernandez at the Securities Industry Association. “Much of it is not deep.”
But investors soon will be able to judge for themselves. The global settlement requires that the firms disclose analysts' historical ratings. And in the end, some say, independents may win out.
“I think the independent firms have got a strong advantage in terms of being objective, and not owing anything to anybody,” said Nell Minow, editor of The Corporate Library, an independent research firm in Portland, Maine. “And I think ultimately ten years from now we are going to see that independent research is really all that's left.”